4 year-end considerations for your taxes

Should your tax strategy shift because of the unique circumstances in 2020? Explore these four areas to find out.

It's an understatement to say that 2020 has been a year like no other. The COVID-19 pandemic cost many people their jobs, and legislation designed to provide help also created new approaches for everything from Required Minimum Distributions (RMDs) to student loans—at least temporarily. Add in the uncertainty caused by market volatility and a presidential election, and it's clear that this year is unique.

That's why it's important to think about the moves you can make right now to remain aligned with your long-term financial strategy. Taxes should never be the sole driver of financial decisions, but they can play an important role in your overall financial health. Remember to check with your financial and tax advisors before you make any changes.

Here are four ideas to consider as we approach the end of this crazy year.

1. Review your income this year—and forecast for next year

Your income in a given year is one of the biggest drivers of how much federal income tax you're likely to pay. Remember, too, that different types of income are treated differently by the IRS. For instance, capital gains on the sale of investments is taxed at a different rate than traditional income. Before you decide to make any strategic moves to reduce your 2020 tax obligation, consider if it might be better to wait until next year. For example:

For those not yet retired

If you lost your job and were unemployed for a time this year, you may have more income next year that could put you in a higher tax bracket. If that's the case, you may want to consider whether it makes sense to recognize income from other sources while keeping your income in its current lower tax bracket so that all of it is taxed at a lower rate. If you spent time unemployed but are back at work now, and expect to earn less than you have in previous years, you may want to check your tax withholding from your paycheck to see if you should be withholding less. Remember, though, to change your withholding back at the start of 2021 if you hope to earn more next year.

If you plan on retiring in 2021 and think you may have lower income as a result, it may be smart to postpone any lump sum payments or bonuses, if possible, until a time when you're potentially in a lower tax bracket.

For retirees

The CARES Act brought one of the most significant legislative changes in 2020: the cut of RMDs during this year. If you decided not to take a RMD this year, your income may be lower compared to next year. Again, that makes it potentially a good time to realize other sources of income while staying in the same lower bracket this year.

Converting to a Roth IRA could be especially appealing this year as well. Normally, RMDs can't be converted to Roth IRAs. But because RMDs were waived, any amounts distributed from a traditional IRA may be converted to a Roth IRA; however, you still have to pay the taxes on the amount converted.

One big plus of rolling over 2020 distributions to a Roth IRA is lowered income tax liability years afterward because of reduced RMDs. In most cases, anything you withdraw from a Roth IRA will be income tax-free, though it's best to discuss further with your financial advisor.

2. Maximize your retirement savings

Regardless of whether you'll earn more or less next year, it's almost always a good idea to maximize your retirement savings. Recent laws have changed some of the traditional thinking, making it smart to double-check to make sure you're taking full advantage of the options available to you.

Retirement account contribution limits

Retirement account

Source: Internal Revenue Service

The SECURE Act that was signed into law in late 2019 got rid of the age restriction on contributions to traditional IRAs. So even if you’re over 70.5 years old, you can still contribute. For those still contributing to an employer plan, such as a 403(b) or 401(k), 2020 maximum contribution limits went up slightly to $19,500, and for those over age 50, catch-up contribution limits increased to $6,500.

It may also be smart to check with your employer about any other programs, such as deferred compensation, that you may be eligible for that can help you save for retirement.

3. Find opportunities based on what happened in 2020

Now's a good time to look at your overall financial picture. You may have had unexpected healthcare expenses you needed to cover that put a dent in your budget. Alternatively, if you didn't take the big vacation you had planned, you may have more money in cash than you traditionally do at the end of the year. This big-picture review may also tell you if you have discretionary income to open and fund a Roth IRA if you qualify and want to diversify your retirement savings.

As you take a look at the balances of your accounts, also consider whether you need to bolster your emergency savings.

If you faced financial hardship in 2020 as a result of the pandemic, you had the option of taking a coronavirus-related distribution from a retirement plan of up to $100,000. This distribution is exempt from the traditional 10% penalty if you are under age 59.5. You have the option of spreading the distribution's tax impact out over the next three years, or you can treat the entire thing as taxable in 2020.

The market volatility of 2020 may also create more opportunities than usual for tax loss harvesting. Tax loss harvesting is the strategy of selling investments that have lost money in order to offset investment gains on stocks or other assets you may have sold for a profit earlier in the year. This can be a tax-efficient way to approach balancing your investment portfolio. Your financial advisor and tax advisor can help you understand if your portfolio is out of balance after a year of volatility, and whether selling some investments before the end of 2020 may benefit you.

4. Revisit your charitable giving strategy

The CARES Act has temporarily changed rules around charitable contributions. For those who take the standard deduction, you still may be eligible for a maximum $300 "above-the-line" deduction for cash gifts to charities. These cash gifts must be made to a qualified charitable organization, and cash gifts to donor advised funds are not eligible.

If you are still itemizing your deductions, the CARES Act helps you as well. In 2020, you can deduct up to 100% of your adjusted gross income for any cash gifts, up from 60%. That may make this year a time to donate cash instead of appreciated securities, or to do some legacy planning.

For anyone who planned on taking a qualified charitable distribution from an IRA this year, it may be wise to wait until next year due to the suspension of RMDs in 2020. However, if you take a qualified charitable distribution this year, it still does not show up as taxable income.

Talk to your advisors about specific strategies

Every person's situation is unique, and there may be other considerations that impact your 2020 taxes.

Remember to talk to your financial advisor and tax advisor about what’s happened to you in 2020 and how it may impact your taxes before you make any year-end moves.

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